ARGENTINE DEFAULT 2.0?

Takeaway:Argentina's options have not changed: default or burn the peso. Neither outcome is good for sentiment surrounding beleaguered EM assets.

CONCLUSIONS:

What does Cristina Fernandez need to do to stem the tide of currency depreciation, commensurate inflation and capital flight? That’s “easy”: default on its foreign debt obligations and commit to servicing the citizens of Argentina vs. the assets of foreign creditors. A change in monetary regime (i.e. re-pegging the ARS to the USD) wouldn’t hurt either.

Since we know that all of that occurring in the near term is unlikely, it is likely that Fernandez & Co. will continue to burn the peso in order to inflate FX reserve balances. That outcome continues to be priced into the forwards market; consensus has this one right – at least directionally.

What investors might be missing is the eccentric Cristina Fernandez waking up one day, realizing that there is no end in sight, and deciding to pursue the default option.

It’s definitely a risk worth considering heading into 2015; the country’s USD debt service obligations (principal + interest) jump to $9.5B that year (from $3.3B in 2014). After a brief respite in 2016, the maturity wall stiffens again with $11B-plus due in both 2017 and 2018.

At any rate, neither outcome (default or material devaluation of the peso) is good for sentiment surrounding beleaguered EM assets.

I feel bad writing so negatively about Argentina’s managerial woes. Typically when our firm publishes bearish research on companies, usually the worst thing that could happen is a bunch of overpaid corporate executives lose their jobs as a result of persistently poor operational performance. For countries, however, the ramifications of persistent mismanagement are considerably more far-reaching.

In recent years, Argentina has been a standard bearer in this regard:

Since President Cristina Fernandez office back in DEC ‘07, the Argentine peso (ARS) has been devalued by roughly -60%; today’s -11% decline to ~8 pesos per USD represents the largest single-day drop since the country abandoned its peg to the USD back in 2002.

Reported inflation (+10.6% YoY in 2013) has consistently trailed actual inflation in Argentina, where private sector economists are now prosecuted for publishing estimates (+28.4% YoY in 2013) that conflict with official readings.

In the face of rampant inflation and punitive capital controls (including additional measures introduced today, which limit consumers to two online purchases from overseas providers per year), Argentine citizens have been increasingly dealing with blackouts and looting – eerily reminiscent of conditions on the ground post the country’s 2001 default on $95B of foreign currency debt.

For those Argentines brave enough risk jail time by circumventing official capital controls, they are now paying a record 12.15 pesos per USD for blue-chip currency swaps in the black market (i.e. ~50% more expensive than the official spot rate), which took off once Fernandez began restricting access to foreign currencies after her re-election in 2011.

So why is Cristina Fernandez, who recently replaced her economy minister, cabinet chief and central bank governor back on NOV 18th (her first day back in office after surgery to remove a blot clot near her brain) – after stating emphatically back in MAY that Argentina wouldn’t devalue the peso – burning her country’s currency?

As we were keen to highlight in our previous work on Argentina, the Argentine sovereign’s primary issue lies in its ~$50B outstanding of restructured and un-restructured foreign currency debt and the primary source of funds it taps to service that debt – i.e. central bank FX reserves, which have declined by -44% since peaking in JAN ‘11.

Specifically, our long-held and accurate bearish bias on the commodity complex has slowed Argentina’s accumulation of FX reserves via the current account (commodities account for ~65% of Argentine exports) – which is now persistently in [slight] deficit territory after having averaged a healthy +3.5% current account surplus during the 2002-10 run-up in global commodity prices.

It’s too bad for Argentina that commodity prices peaked and started to decline in 2011 – just as our #DeflatingTheInflationII 1Q12 Macro Theme (and subsequent macro themes throughout 2012-13) called for them to do. Either you have a process for internalizing and capitalizing on globally interconnected risks or you don’t.

We did. Argentine policymakers didn’t. That’s probably why the peso has declined/been devalued by a cumulative -44% since we started pounding the table on the short side of the ARS (in the NDF market, of course) back in APR ’12.

So what does Cristina Fernandez need to do to stem the tide of currency depreciation, commensurate inflation and capital flight? That’s “easy”: default on its foreign debt obligations and commit to servicing the citizens of Argentina vs. the assets of foreign creditors. A change in monetary regime (i.e. re-pegging the ARS to the USD) wouldn’t hurt either.

Since we know that all of that occurring in the near term is unlikely, it is likely that Fernandez & Co. will continue to burn the peso in order to inflate FX reserve balances. That outcome continues to be priced into the forwards market; consensus has this one right – at least directionally.

What investors might be missing is the eccentric Cristina Fernandez waking up one day, realizing that there is no end in sight, and deciding to pursue the default option. It’s definitely a risk worth considering heading into 2015; the country’s USD debt service obligations (principal + interest) jump to $9.5B that year (from $3.3B in 2014). After a brief respite in 2016, the maturity wall stiffens again with $11B-plus due in both 2017 and 2018.

Source: Bloomberg LP

At any rate, neither outcome (default or material devaluation of the peso) is good for sentiment surrounding beleaguered EM assets.

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